There are many similarities between forex and virtual currency markets. The most obvious is that both markets are based on “currencies,” although it is debatable if the two are equivalent. In addition, both markets entail complex structures and are decentralized by nature. Lastly, many virtual currencies not only emulate fiat currency in their utility, but also have digital and social economies that have effects on the pricing, similar those of fiat currencies.
While the forex markets have been maturing since the 1970s, virtual currencies have only been in existence since 2009. Their origin and rise to prominence have been purely through trading, with very little use outside of financial markets. As such, the value of virtual currencies has been primarily speculative and based on the short and long term investments as well as volatility trading.
The traditional on and off ramps from fiat currencies to the virtual world have been either through retail aggregators, in the form of “cryptocurrency exchanges”, or through OTC trades and brokers. Until recently, regulation has stopped banks from participating, but that has started to change with many banks setting up trading desks and accepting deposits. This opens the doors to dual-purpose banks that act as dealers in the forex markets, but also dealers in virtual currencies.
While foreign currency markets are separated into inter-dealer and customer service networks, virtual currencies are separated into fiat and virtual domains. Virtual currencies only exist within the virtual domain, while fiat currencies flow primarily between three different actors - retail aggregators, OTC dealers, and more recently bank platforms. Retail aggregators consist of virtual currency exchanges where retail trades occur, whereas larger trades take place through OTC desks given their better tolerance for slippage risk common to illiquid markets. Bank platforms are emerging as regulators begin to authorize the first “crypto-banks” to be licensed.
Within the virtual domain, flows are highly interconnected between all parties with permissionless access to decentralized exchanges as well as other platforms. The network effects created by this interconnectedness is the primary advantage. Volatility, regulations, lack of infrastructure, and limited on-ramps from fiat currency are restricting virtual currencies from being used as the mainstream payment vehicle. The primary on-ramps are through retail aggregators as well as OTC desks managed by the same retail aggregators.